Canadian housing – Foreign ownership – II

newtonNewton’s third law of motion states: “For every action, there is an equal and opposite reaction”. A good example is a wind up clock mechanism. You wind up the key in one direction to store energy in the spring coil. It progressively unravels in the other direction releasing energy stored in the spring coil and in the process showing the time. The unwinding is orderly due to mechanical interference to control the rate of unwinding.

If we take this example and look at any field of human behaviour we see logical parallels. Take the field of politics or economics. If there is excessive shorting of a stock, there is a pressure on the shorter to cover the short and this drives up the price of the stock. Markets ebb and flow based on opposing forces of bulls and bears.

The recent history of business indicates that manufacturing and back office processes have been outsourced to less developed countries because of cheap labor. The labor is cheap because of the absence of adequate infrastructure and governance overheads. Lesser developed countries have cheaper currencies that make the labor even cheaper. This indirectly boosts productivity in Dollar terms. This also provides for inflation in the outsourced country due to increase in currency in circulation. Typically such countries have high interest rates on deposits as they try to fight inflation.

There will always be a section of people in these countries that benefit disproportionately from this economic activity. These people will have to pay disproportionately large amount of taxes. Naturally, the expected reaction will be to avoid taxation. This leads to a flight of capital to other jurisdictions where the value is preserved and enhanced and preferably is tax free.

Over the years the developed nations have been pouring trillions of dollars into the developing economy through outsourcing. A good portion of that money has returned through different channels in search of a safe, secure and lucrative pace to invest. That place happens to be either Australia, England, Canada or United states and the sector that proves most attractive is Real Estate.

Everything looks hunky dory as long as local currency is progressively devalued to attract more outsourcing. This makes foreign Real Estate investments seem to grow on steroids when converted to local currency. Ceteris Paribus – other things being constant; this situation will continue. However, in real life nothing is constant. As participant (let us call him Joe) of a developing economy keep sending money abroad, the ability of the developing country to re-invest in production facilities gets compromised. This leads to economic problems and hastens further decline in exchange rate. When this happens, Joe finds that he has a fortune stashed abroad while at home he is starving. If he bought back his fortune, he could live a very lavish lifestyle at home. If he proceeds to get the money back home, we would see reverse capital flow. Money sucked out of the real estate market in these target countries.

Take the other case where a developing country has managed its economy properly and has transformed into a developed economy. In that case the local currency will get stronger and investments made abroad will depreciate in value. If the future prospects of a developing country are strong, participants would be in a rush to take out their foreign investments as soon as possible to avoid further erosion of value. this can hasten a flight of capital from foreign real estate markets.

On the other hand, developed economies that keep outsourcing will find that their local market does not have purchasing power. The solution they say is to transition to higher value added services sector. However, the mobility of manpower from manufacturing to value added services is not a smooth path. Newly minted graduates are cheaper to hire and more malleable as compared to hardened older manufacturing labor. Not to mention the retraining. In the recent past, there has be questions around the worth of a college degree given the costs to acquire one and the salary prospects afterwards.

Income inequality of the proportions that we currently have where 1% of the population owns 99% of the wealth creates a further problem where the 1% is living in a different world and experiences a different reality. The rest of the 99% still cling to the social terms of engagement because there is still hope that the system will work for them eventually. The tipping point is when that hope is lost. The job of the government is to constantly refine the terms of engagement in light of emerging situations and make sure that every one has level playing field and stays engaged.

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